Futures Industry | January 2015 47

By Joanne Morrison

Nodal Creates New Clearinghouse for Power Futures

The exchange, which is owned by DC Energy, NextEra Energy Resources, Macquarie and a private equity con-

cern, began operating roughly six years ago, catering to wholesale power producers and consumers who buy and sell energy on a broad scale in the bilateral and spot markets.

Over time the exchange has grown, and today it provides market participants with the ability to hedge the price of electricity at hundreds of speci�c locations around the country. �e exchange estimates that roughly half of its volume comes from physical hedgers, 20% from �nancial enti-ties and 30% from banks.

In 2013 Nodal changed its business model to comply with Dodd-Frank rules, shifting trading from an auction style for-mat to a traditional central limit order book approach, and registered with the Com-modity Futures Trading Commission as a designated contract market.

Now, sitting in the number two spot in terms of U.S. power market futures volume, Nodal is moving ahead with the next stage of its evolution—building its own clearinghouse.

Why Build a Clearinghouse?

Since trading began in 2009, Nodal has been o!ering clearing through LCH.Clear-net Ltd., but in November, the exchange announced plans to transition away from LCH.Clearnet in the latter half of this year. An application to become a derivatives clearing organization was submitted in De-cember and is now pending at the CFTC.

Paul Cusenza, chairman and chief execu-tive o"cer of Nodal, explained that relying

on the London-based clearinghouse was a good strategy when the exchange started, but now bringing clearing in-house makes more sense. “It’s part of a natural transition that allows us to continue to expand,” said Cusenza.

Cusenza cited several reasons for the move. For one thing, LCH.Clearnet is a London-based clearinghouse, and there-fore activity and participation on Nodal Exchange involves oversight from three

Nestled in a non-descript office building in the Northern Virginia suburbs of Washington, D.C. is a

trading platform, Nodal Exchange, that handles nearly 14% of all U.S. power futures trading.

Ann Sacra, president and chief

operating officer, and Paul Cusenza,

chairman and CEO of Nodal, are

building a clearinghouse.

48 Futures Industry | www.fia.org44888 FutFutFutFutFutFutFutFutFutFutFutFutFutureureureureureures Is Is Indundundundundundundundundundundundundundundundundundundundundundundundundundundundundundustrstrstrstrstrstrstrstrstrstryyyy |||||| wwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwwww.fi.fi.fi.fi.fi.fi.fi.fi.fi.fi.fi.fia.oa.oa.oa.oa.oa.oa.oa.oa.oa.oa.oa.oa.orgrgrgrgrgrgrg

Nodal Exchange

NODAL CLEAR

WATERFALL

Unfunded Contributions — Assessment

Nodal Clear Contribution $20 million

Defaulter’s Initial Margin

Guaranty Fund

Defaulter’s Guaranty Fund Contribution

Service Continuity Phase

Closure

di!erent regulators: the CFTC in the U.S., the Bank of England in the U.K., and the European Securities and Markets Author-ity in the EU.

“It certainly simpli�es things to have a single regulator rather than three,” Cusenza said. “�at’s a plus for us and the clearing members themselves.”

Clearing �rms agree. “We had a chal-lenge being an active member and trying to adhere to multiple masters,” said Patrick Bobay, managing director in the futures di-vision at Mizuho Securities U.S.A., one of a dozen �rms that clear Nodal trades through LCH.Clearnet.

Faster Approvals

David Sotelo, who runs the energy team at ADM Investor Services, another �rm that clears Nodal trades, is optimistic that bringing clearing in-house will allow the exchange to list new products more easily. �at is particularly important in the U.S. power market as pricing within very spe-ci�c regions of a transmission system can change daily.

“As they developed new products, it was quite cumbersome to get things approved,” said Sotelo, whose �rm has been clearing Nodal’s contracts since the platform went live in 2009. “I think bringing things on-shore will allow them to move quicker for new products.”

Another complication has been the dif-ferences in U.S. and U.K. bank holidays and settlement times. “Cutting down all that lag time is going to make it a better exchange overall,” Sotelo added.

Power market participants also under-scored the volatility of power prices and the need for frequent adjustments to mar-gin requirements. “During the Polar vor-tex, margins were bouncing all over the place,” explained Mizuho’s Bobay. LCH.Clearnet added a “bu!er” to its margin requirements, but the size of the extra margin was not communicated clearly. �at caused di"culties for Mizuho’s cus-tomers, Bobay said. “Most of our custom-ers are large sophisticated organizations that have treasury teams that try to track and forecast what their margins are going to be,” he explained.

Sizable Market Share

In the overall power market, Nodal esti-mates that it has roughly 13.6% of the vol-ume in terms of total terawatt hours, versus 83% for ICE and 3.4% for CME. In terms of open interest, Nodal held 24.4% of open interest measured in terawatt hours versus 65.1% at ICE and 10.5% at CME.

�e bulk of Nodal’s volume is in basis trades, whereas the other two exchanges’ contracts are primarily based on prices for a hub. �e fact that Nodal o!ers contracts based on nodes allows power producers to hedge price risk at very speci�c locations. �at is especially important in the power market, because prices can vary signi�-cantly from one location to another.

Some of the heaviest trading at Nodal is in contracts based on nodes in PJM, the regional transmission operator covering the movement of wholesale electricity across a 12-state region stretching from the midwest to the mid-Atlantic. Nodal’s contracts also cover power prices in other markets such as MISO, ISO-NE, ERCOT, NY-ISO and CAISO.

Skin in the Game

As part of the clearinghouse structure, Nodal is putting up $20 million of its own capital. In the case of a default, this capital would be used to cover any losses before the clearinghouse taps its guaranty fund, which will be funded by members.

“We expect that our $20 million of eq-uity that sits in front of the guaranty fund will be about 20% of the total guaranty fund size,” said Cusenza. Nodal estimates that the $20 million amount will be larger than any single clearing member’s contri-bution. “We think we are putting more at risk than our largest clearing member,” Cusenza said.

Nodal’s clearinghouse will have the abil-ity to ask clearing members to contribute additional amounts to replenish the guar-anty fund in case of losses from a default. However this amount will be capped at 200% of the clearing member’s required deposit in case of a single default and 550% in case of multiple defaults within a six month period.

We expect that our

$20 million of equity

that sits in front of the

guaranty fund will be

about 20% of the total

guaranty fund size.

PAUL CUSENZA, Nodal CEO

Futures Industry | January 2015 49

VaR Margining

�e new clearinghouse will use a value-at-risk methodology to calculate margins, aligning with the approach used in the bi-lateral power markets. Nodal’s contracts have been margined that way since inception, and the bene�t is that it has allowed power mar-ket participants, who traditionally engage in a wide range of bilateral deals as well, to calculate margins on a portfolio basis across similar, but not necessarily identical futures, forwards and swaps. In contrast, ICE and CME have relied on SPAN (standardized portfolio analysis of risk) margining for their power contracts, although both exchanges are now in the process of developing a VaR-like margining methodology for their com-modity contracts.

“�e right amount [of margin] means be-ing able to understand what you need to do from a risk and margining perspective and we think we at Nodal Exchange really under-stand the risk of the power market extremely well, which is why we can make a transition to a clearinghouse role,” said Cusenza.

What’s Next?

Nodal’s application with the Commod-ity Futures Trading Commission to become a derivatives clearing organization was sub-mitted in December. Once approved, the exchange operator expects to transition clearing from LCH.Clearnet in the latter half of this year.

In addition to clearing its own listed products, Cusenza said Nodal will also be positioned to o!er third party clearing for certain market transactions in the power market such as �nancial transmission rights awarded by independent system operators and regional transmission organizations. �ese contracts, auctioned monthly, are currently bilateral.

“What we focus on is the power mar-kets. �ey are their own unique space,” said Cusenza.

ADM Investor Services, Inc.

BNP Paribas Prime Brokerage

Citigroup Global Markets Inc.

*Deutsche Bank A.G.

Goldman Sachs & Co.

Jefferies, LLC.

*Merrill Lynch International

Mizuho Securities USA Inc.

Morgan Stanley & Co, LLC

RBC Capital Markets, LLC

SG Americas Securities, LLC

Current Nodal Clearing

Members

Note: These are clearing members who are cur-

rently clearing through LCH.Clearnet Ltd.

* Deutsche Bank and Merrill Lynch International

have non-FCM membership.

..............Joanne Morrison is deputy editor of

Futures Industry.

Position Limits and Exchange Fees Data Solutions

Obtaining accurate position limits and exchange fees data on a daily basis typically is an

arduous and time-consuming task. To ease the burden, IFM offers three unique, industry

utilities — the Position Limits Databank (PLD), Equity Options Position Limits Databank

(EOPLD) and Exchange Fees Databank (EFD).

Ask us how we can simplify your informational needs and lower your costs.

Data Subscription Features

Global data coverage updated and validated to eliminate inconsistencies and omissionsGlobal data coverage updated and validated to

Supplementary email notices and alerts to stay informed of proposed and immediate Supplementary email notices and alerts to stay informe

changes and new product introductionschanges and new product introductionschanch

IFM Data Center Help Desk to answer questions or research concernsM IFM Data Center Help Desk to answer questions or research coIFM IFM M M DaDaDaDaM IFM IFIFIFM

The IFM is a nonprofit foundation and

an independent affiliate of the FIA.

The IFM provides unbiased education

and information. See our website for

details, or contact us for an online

demonstration.

WEB www.theIFM.org

TEL 202.223.1528

EMAIL info@theIFM.org